Market Preview: US-Canadian Exchange Rate More Balanced

by 5m Editor
8 November 2008, at 4:55am

US - Weekly US Market Preview provided by Steve R. Meyer, Ph.D., Paragon Economics, Inc.

“It was the best of times. It was the worst of times.“ So began Dickens’ “A Tale of Two Cities.“

While today doesn’t actually represent either the best or worst times for Canadian pork producers, it certainly presents two very opposite, but simultaneous, occurrences – a weaker Canadian dollar and mandatory country-of-origin labeling (COOL). I’ll address the exchange rate this week and gladly put off the mandatory COOL discussion until next.

The weaker Canadian dollar has provided a virtually instantaneous increase in prices received by Canadian hog producers relative to their U.S. counterparts. That is not to say that prices are good in Canada. They just have not fallen nearly as much as they have in the States. The simple reason is that a weaker Canadian dollar (i.e. more $Can needed to make one $US) translates a given U.S. price into more Canadian bucks.

Figure 1 shows historic weekly hog prices for the United States and Canada (restated to $US/kg). I use Ontario prices simply because all Canadian prices are highly correlated and the Ontario prices were usually within the range of the other provincial prices. I could use any Canadian price series and make my point because in recent weeks, Canadian prices have stayed constant while U.S. prices have fallen sharply.

This is no panacea, however. The weaker Canadian dollar also increases the cost of any inputs whose prices are determined by the U.S. market. Therefore, most feed costs have increased relative to those of U.S. producers. However, only about 60% of Canadian production costs are tied to U.S. prices, so Canadian producers win as virtually all of their income grows and only a portion of their costs grow. That is the flip side of the forces that have hammered Canadian producers since the loonie (a nickname for the Canadian dollar; the coin has a loon on it) began gaining value back in early 2003.

A further benefit of a weaker loonie is just now being felt as Canadian product is more competitive in world markets. The cheap U.S dollar has provided a pricing advantage to U.S. exporters for some time. The rising dollar and, especially, the falling loonie, make Canada’s products relatively better buys. I understand that Canadian sellers are making substantial gains in Japan and China where currencies have gained more relative to the Canadian dollar than to the U.S. dollar.

I have also divided Figure 1 into three pretty distinct periods. The first, 2002 through most of 2004, was characterized by relatively high prices in Canada that were trending back toward U.S. prices as the Canadian dollar gained about 25% in relative value. Canadian breeding herd growth peaked at 7.6%, year-over-year, in January 2002. The first year-over-year decline in nine years occurred in April 2005 – shortly past the end of the red-boxed period.

The third period (blue box) runs from the beginning of 2006 through the third quarter of this year. It is characterized by low Canadian prices relative to U.S prices and a huge (12.9%) reduction in Canada’s breeding herd.

The other period (green box) is the one I find most interesting. From Q4-’04 through 2005, the exchange rate averaged $Can1.21/$US (or $US 0.82/$Can, if you prefer). During that period, Canada’s year-over-year breeding herd changes were +1.6, +1.0, -0.03, -0.7 and -0.3%. The year-over-year breeding herd change in the United States was less than 1% in either direction in all five of those quarters. I know there were many other factors at play, but it certainly appears that the U.S-Canadian pork industries might be more compatible at a ratio of about $1.20:$1.00, doesn’t it?

And look where we are now: Roughly $1.20:$1.00. That doesn’t mean things will be stable, since everyone is losing money at current feed and hog prices. But it does suggest that the signals may be more even-handed than they have been, thus allowing the two countries’ producers to move in tandem, perhaps, rather than in opposition.

So do you think we can get Ben Bernanke and Mark Carney (for U.S. readers, Carney’s the Governor of The Bank of Canada) to cooperate a little based on this evidence? Probably not, especially with the number of alligators both of them are fighting during the current financial swamp draining. But at least we have a bit of context in which to place our exchange rate and what has happened in the past to the U.S. and Canadian hog herds.